With my research on robo-advisors, I ran into many different portfolio allocation strategies. Some advised 90% or more in stocks for young investors, while others limited it to 70%. Nearing retirement, some actually recommended cutting your portfolio down to 25% stocks while investing the rest in bonds; others suggested 50% or more in stocks. It’s easy to understand why people are confused when they see such conflicting advice.
Four stages
I’ve divided this into four stages – your starting years until you reach your 40s, your middle years where you’re either tweaking the allocation or catching up to where you should be, pre-retirement, and retirement. Some sites suggest you change your allocation every ten years (i.e., in your 20s, 30s, etc.) but my belief is if you’re 30 years or 40 years from retirement, you still have time to overcome down markets. Going from 87% stocks to 82% stocks as some advisors suggest seems a waste of time.
Note – before you go forward, these are general suggestions. I’ve known people who have been 100% invested in stocks and used their house and checking account as emergency funds so they wouldn’t have to sell when the markets were down. Other people have been much more conservative, almost to the point of reducing their chance at a comfortable retirement because they were so worried about losing money in the markets. Neither is right or wrong – it’s up to you to decide how risk averse you are and what you will do when the markets tank.
In your 20s and 30s
When you’re just starting out you can afford to invest aggressively in your portfolio as you have years to make up any losses in your accounts. You almost certainly will see your portfolio drop in value from time to time over a 40- or 50-year investment horizon. If you are going to choose the path of the ultra-aggressive investor mentioned above, make sure you have a way to access cash so you aren’t forced to sell during a downturn. It can be a savings account, contributions to a Roth IRA, or you might consider equity in your house.
In my research, most professionals recommended 80 – 90% in stocks, with the rest in bonds or a bond/cash mixture. You can obviously split the stock portion between US and international or small-cap and large-cap. Many of you may want to just pick a couple of cheap index funds and push your investments into them.
40s and 50s
Somewhere during your early 40s you should take a Sunday afternoon and review where you are. Have you been saving like you thought? Have your investments done well? Did you lose track and suddenly find yourself a little behind where you want to be? It’s better to start asking these questions now when you still have 20 or more years until retirement than to wait until you’re 10 years away from needing the money.
For the next 20 years, you may choose to be more balanced in your approach to investing. Chances are you will still have one or two market corrections or downturns before you reach age 65. But you also still need growth from more aggressive investments to achieve a comfortable retirement.
Many planners suggest people in their 40s and 50s consider keeping 70% to 80% in stocks and the rest in bonds/cash. Again, this depends on your risk tolerance, but also on your retirement goals. While your retirement lifestyle may have seemed an eternity away when you were 20, you should have a clearer idea of how you might want to spend your “second act”. Will you need a huge bankroll or will you be happy gardening in the house you’ve almost paid off? The answer will not only help determine your allocation needs but also the amount you should devote to retirement.
One caveat – if you discover that you let retirement fall by the wayside and you’re starting out at age 42, don’t overcompensate by investing everything in extremely risky investments. You still have 20+ years to fully fund your workplace retirement plan, invest in an IRA, and perhaps build up an after-tax account on the side. Look at your alternatives and develop a plan now.
And it wouldn’t hurt to revisit your plan when you’re 55, whether you’re on track or not. Turning 55 means that you’re only seven years from early Social Security benefits, which really puts retirement into perspective. You may also have more concrete ideas of how you’ll spend retirement.
60s – almost there
When you hit 60, you can almost feel your toes in the sand or imagine the trips to Europe. This is definitely not the time to be overly risky with your investments, but you also can’t completely move away from stocks. Many people close to retirement are finding in today’s environment that they need more in stocks than previously suggested because of the lack of returns from bonds and cash. Still, you have to be comfortable with your decision.
A range of 50% stocks and 50% bonds/cash to perhaps 65% stocks and the remainder in bonds/cash are estimates you may feel comfortable using. This might also be a good time to meet with a planner, especially if you’ve been a DIY investor for your career, to talk about how to withdraw money from your accounts so it has the best chance of lasting throughout your retirement. This is something you can do on your own too, but many find going from net saver to net spender to be a difficult transition.
Retirement
While retirement will start at age 62 for some, many wait – either by choice or necessity – until later to stop working. The longer your investments can grow, the better off you’ll be. However, this should be balanced if you’ve saved enough and can begin enjoying your golden years immediately.
Some people in retirement choose to keep a liquid account for expenses that covers several years so their investments can keep working. Others pull money out of their main investment account and reallocate their remining funds. Still others say the heck with it and buy an annuity to provide income.
Whatever you choose, you should still have some exposure to stocks. Experts suggest 25% – 50% with the remainder in bonds and cash.
Your Choice
When looking at your age group, use the suggestions as guidelines. Maybe you are young and feel more aggressive, or maybe you lost 50% of your portfolio in 2008 and never want that to happen again. Whatever you decide, the main goal is to keep investing for retirement. You’ll thank yourself when you’re relaxing on the beach.
Photo by Alex Perri